When it comes to the task of creating a portfolio, one is to manage the risks connected to it by resorting to a strategy of diversification. A diversified portfolio is the one containing a combination of different types of assets and investment instruments in an attempt to limit exposure to an individual asset or risk. For instance, in terms of stocks from the technology sector, one could choose from various businesses offering products and services in computers, software, electronics, artificial intelligence, and other IT-related industries. Evidently, some of the most popular options are companies with the world’s largest market capitalization, including Microsoft Corporation, Apple Inc., and Amazon.com Inc. However, when creating a diversified portfolio, it is reasonable to select from stocks that are most valuable from different perspectives.
First of all, stocks that always get picked are those with the best value. According to Reiff (2022), currently, among the best value tech stocks are Hewlett Packard Enterprise (HPE) and Mandiant Inc. (MNDT). HPE’s current price is $15.38, and its previous 1-year and 5-year rates of return (ROR) are -3.57% and 9.17% respectively, while MNDT’s corresponding indicators are $22.35, 5.73% and 36.98% (Reiff, 2022). Moreover, it is worth investing in the fastest growing tech stocks, among which, according to Reiff (2022), are Microchip Technology Inc. (MCHP) and Avnet Inc. (AVT). MCHP’s current price is $65.22, with its previous 1-year and 5-year ROR being -6.59% and 67.32% respectively (Reiff, 2022). AVT’s current price is $37.13, 1-year ROR are 6.40%, and 5-year ROR are 24.97% (Reiff, 2022). Finally, there are stocks with the most momentum, that is, their price rises faster than the market. As per Reiff (2022), among such stocks are Switch Inc. ($30.81, 79.85% and 60.60% ROR for previous 1 and 5 years) and Fortinet Inc. ($331.76, 37.79% and 596.04% ROR for previous 1 and 5 years). Added to a portfolio, all of these are to diversify its risk.
In business, risk is the likelihood of the occurrence of some adverse event. Brigham and Ehrhardt (2020) note that, for investments in new projects or financial assets, such an event is obtaining a lower return than expected. The risk of an asset can be considered in two different ways. There is a risk on a stand-alone basis, with the asset analyzed in isolation, and then there is a risk on a portfolio basis, with the asset analyzed as one of a portfolio’s several assets (Brigham & Ehrhardt, 2020). According to Brigham and Ehrhardt (2020), almost half of the risk resident in a single stock can be obliterated if the stock is kept in a portfolio that is diversified enough. This is the reason why this portfolio features stocks from six companies that are leaders according to three different criteria: two by value, two by growth, and two by momentum. Since much of the risk of any single stock can be terminated simply by keeping many stocks in a portfolio, it is reasonable for rational investors to do just that.
Furthermore, in equilibrium, a stock’s expected ROR must be equal to its required returns. However, there are things that might cause the change of the required ROR, among which are the change of investors’ aversion to risk. Brigham and Ehrhardt (2020) explain it in the following way: Security Market Line’s slope reflects the degree of investors being risk-averse. The increased investor’s risk aversion causes the raising of the risk premium, which results in a steeper slope of the Security Market Line.
Finally, it is important to highlight the distinction between a stock’s market price and its intrinsic value. As per Brigham and Ehrhardt (2020), an asset’s intrinsic value includes all relevant data on its expected cash flows and potential risks, as well as information about the company and economic and political environments. As opposed to intrinsic value, market prices depend on the selection and interpretation of data by investors. Market prices deviate from intrinsic values to the degree of investors not selecting and interpreting relevant data correctly.
References
Brigham, E. F., & Ehrhardt, M. C. (2020). Financial management: Theory and practice (16th ed.). Cengage Learning.
Reiff, N. (2022). Top tech stocks for May 2022. Investopedia. Web.